Professional Documents
Culture Documents
Raising Equity
Capital
• Sources of Funding:
A private company can seek funding from several
potential sources:
Angel Investors
Venture Capital Firms
Institutional Investors
Corporate Investors
There are typically six stages of venture round financing offered in VC,
that correspond to these stages of a company's development.
• Seed funding: Low level financing needed to prove a new idea, often
provided by angel investors.
• Start-up: Early stage firms that need funding for expenses associated
with marketing and product development
• Growth (Series A round): Early sales and manufacturing funds
• Second-Round: Working capital for early stage companies that are
selling product, but not yet turning a profit
• Expansion : Also called Mezzanine financing, this is expansion
money for a newly profitable company
• Exit of venture capitalist : Also called bridge financing, 4th round is
intended
Copyright to finance
© 2009 Pearson Prentice Hall. Allthe "going public" process
rights reserved. 13-10
Figure 13.1 Most Active U.S. Venture
Capital Firms in 2006
• Institutional Investors:
pension funds, insurance companies, endowments,
and foundations
may invest directly in private firms, or may invest
indirectly by becoming limited partners in venture capital
firms
• Corporate Investors:
Many established corporations purchase equity in
younger, private companies
Corporations might invest for corporate strategic
objectives in addition to the desire for investment returns
Problem:
• You founded your own firm two years ago. You
initially contributed $100,000 of your money
and, in return received 1,500,000 shares of
stock. Since then, you have sold an additional
500,000 shares to angel investors. You are now
considering raising even more capital from a
venture capitalist (VC).
Problem (cont’d):
• …This VC would invest $6 million and would
receive 3,000,000 newly issued shares. What is
the post-money valuation? Assuming that this is
the VC’s first investment in your company, what
percentage of the firm will she end up owning?
What percentage will you own? What is the
value of your shares?
Solution:
Plan:
• After this funding round, there will be a total of
5,000,000 shares outstanding:
Your shares 1,500,000
Angel investors’ shares 500,000
Newly issued shares 3,000,000
Total 5,000,000
Plan (cont’d):
• The VC is paying $6,000,000/3,000,000=$2/share. The
post-money valuation will be the total number of shares
multiplied by the price paid by the VC. The percentage
of the firm owned by the VC is her shares divided by
the total number of shares. Your percentage will be
your shares divided by the total shares and the value of
your shares will be the number of shares you own
multiplied by the price the VC paid.
Execute:
• There are 5,000,000 shares and the VC paid $2 per share.
Therefore, the post-money valuation would be 5,000,000($2) =
$10 million.
• Because she is buying 3,000,000 shares, and there will be
5,000,000 total shares outstanding after the funding round, the
VC will end up owning 3,000,000/5,000,000=60% of the firm.
• You will own 1,500,000/5,000,000=30% of the firm, and the
post-money valuation of your shares is 1,500,000($2) =
$3,000,000.
Evaluate:
• Funding your firm with new equity capital, be it from
an angel or venture capitalist, involves a tradeoff—you
must give-up part of the ownership of the firm in return
for the money you need to grow. The higher is the price
you can negotiate per share, the smaller is the
percentage of your firm you have to give up for a given
amount of capital.
Problem:
• You founded your own firm three years ago.
You initially contributed $500,000 of your
money and, in return received 100,000 shares of
stock. Since then, you have sold an additional
50,000 shares to angel investors. You are now
considering raising even more capital from a
venture capitalist (VC).
Problem (cont’d):
• …This VC would invest $15 million and would
receive 1,000,000 newly issued shares. What is
the post-money valuation? Assuming that this is
the VC’s first investment in your company, what
percentage of the firm will he end up owning?
What percentage will you own? What is the
value of your shares?
Solution:
Plan:
• After this funding round, there will be a total of
1,550,000 shares outstanding:
Your shares 500,000
Angel investors’ shares 50,000
Newly issued shares 1,000,000
Total 1,550,000
Plan (cont’d):
• The VC is paying $15,000,000/1,000,000=$15/share.
The post-money valuation will be the total number of
shares multiplied by the price paid by the VC. The
percentage of the firm owned by the VC is his shares
divided by the total number of shares. Your percentage
will be your shares divided by the total shares and the
value of your shares will be the number of shares you
own multiplied by the price the VC paid.
Execute:
• There are 1,550,000 shares and the VC paid $15 per share.
Therefore, the post-money valuation would be 1,550,000($15) =
$23,250,000.
• Because he is buying 1,000,000 shares, and there will be
1,550,000 total shares outstanding after the funding round, the
VC will end up owning 1,000,000/1,550,000=64.5% of the
firm.
• You will own 500,000/1,550,000=32.3% of the firm, and the
post-money valuation of your shares is 500,000($15) =
$7,500,000.
Evaluate:
• Funding your firm with new equity capital, be it from
an angel or venture capitalist, involves a tradeoff—you
must give-up part of the ownership of the firm in return
for the money you need to grow. The higher is the price
you can negotiate per share, the smaller is the
percentage of your firm you have to give up for a given
amount of capital.
13-36
13.2 Taking Your Firm Public: The
Initial Public Offering
• SEC Filings
Registration Statement
preliminary prospectus or red herring
Final Prospectus
• Valuation
Underwriters work with the company to come up
with a price that they believe is a reasonable
valuation for the firm
Two ways:
estimate the future cash flows
compute the present value
Road Show
Book Building
Problem:
• Wagner, Inc., is a private company that designs,
manufactures, and distributes branded consumer
products. During the most recent fiscal year,
Wagner had revenues of $325 million and
earnings of $15 million. Wagner has filed a
registration statement with the SEC for its IPO.
Problem (cont'd):
• Before the stock is offered, Wagner’s investment
bankers would like to estimate the value of the
company using comparable companies. The investment
bankers have assembled the following information
based on data for other companies in the same industry
that have recently gone public. In each case, the ratios
are based on the IPO price.
Problem (cont'd)
Solution:
Plan:
• If the IPO price of Wagner is based on a price/earnings ratio that
is similar to those for recent IPOs, then this ratio will equal the
average of recent deals. Thus, to compute the IPO price based on
the P/E ratio, we will first take the average P/E ratio from the
comparison group and multiply it by Wagner’s total earnings.
This will give us a total value of equity for Wagner. To get the
per share IPO price, we need to divide the total equity value by
the number of shares outstanding after the IPO (20 million). The
approach will be the same for the price-to-revenues ratio.
Execute:
• The average P/E ratio for recent deals is 21.2. Given earnings of
$15 million, we estimate the total market value of Wagner’s
stock to be ($15 million)(21.2) = $318 million. With 20 million
shares outstanding, the price per share should be $318 million /
20 million = $15.90.
• Similarly, if Wagner’s IPO price implies a price/revenues ratio
equal to the recent average of 0.9, then using its revenues of
$325 million, the total market value of Wagner will be ($325
million)(0.9) = $292.5 million, or ($292.5/20)= $14.63/share
Evaluate:
• As we found in Chapter 9, using multiples for
valuation always produces a range of
estimates—you should not expect to get the
same value from different ratios. Based on these
estimates, the underwriters will probably
establish an initial price range for Wagner stock
of $13 to $17 per share to take on the road show.
Problem:
• Wagner, Inc., is a private company that designs,
manufactures, and distributes branded consumer
products. During the most recent fiscal year,
Wagner had revenues of $200 million and
earnings of $15 million. Wagner has filed a
registration statement with the SEC for its IPO.
Problem (cont'd):
• Before the stock is offered, Wagner’s investment
bankers would like to estimate the value of the
company using comparable companies. The investment
bankers have assembled the following information
based on data for other companies in the same industry
that have recently gone public. In each case, the ratios
are based on the IPO price.
Problem (cont'd)
Company Price/Earnings Price/Revenues
Solution:
Plan:
• If the IPO price of Wagner is based on a price/earnings ratio that
is similar to those for recent IPOs, then this ratio will equal the
average of recent deals. Thus, to compute the IPO price based on
the P/E ratio, we will first take the average P/E ratio from the
comparison group and multiply it by Wagner’s total earnings.
This will give us a total value of equity for Wagner. To get the
per share IPO price, we need to divide the total equity value by
the number of shares outstanding after the IPO (30 million). The
approach will be the same for the price-to-revenues ratio.
Execute:
• The average P/E ratio for recent deals is 15.0. Given earnings of
$25 million, we estimate the total market value of Wagner’s
stock to be ($25 million)(15.0) = $375 million. With 30 million
shares outstanding, the price per share should be $375 million /
30 million = $12.50.
• Similarly, if Wagner’s IPO price implies a price/revenues ratio
equal to the recent average of 2.1, then using its revenues of
$200 million, the total market value of Wagner will be ($200
million)(2.1) = $420 million, or ($420/30)= $14.00/share
Evaluate:
• As we found in Chapter 9, using multiples for
valuation always produces a range of
estimates—you should not expect to get the
same value from different ratios. Based on these
estimates, the underwriters will probably
establish an initial price range for Wagner stock
of $12 to $15 per share to take on the road show.
• With respect to the regulation on the IPO offer price, prior to 1996, applicants for
new-issue offers are required to offer at fixed price at the time of application with
the final fixed unilaterally up or down by the SC at the time of approval of
application for listing. The final approved price tagged to new shares for public
lottery is determined without resorting to the market demand as it is illegal to
solicit applications prior to the approval of the regulators. The fixed offer price was
typically determined by the SC within a range of prospective price/earnings (P/E)
ratios set for each industry.
• In an effort to enhance transparency and efficiency of the Malaysian stock
exchange, the SC moved towards a market-based pricing mechanism in January
1996. This removal of constraints on IPO price setting permits IPO applicants and
their underwriters to have more freedom in setting the offer price. However, they
have to furnish the basis of their computation in deriving the offer price in their
prospectus. The deregulation of IPO pricing eventually allows IPO firms,
underwriters, and investors alike to make informed decisions about pricing rather
than rely on the regulator to fix prices that were often well below equilibrium
levels.
Copyright © 2009 Pearson Prentice Hall. All rights reserved. 13-52
13.2 Taking Your Firm Public: The
Initial Public Offering
Problem:
• Fleming Educational Software, Inc., is selling 500,000 shares of stock in an
auction IPO. At the end of the bidding period, Fleming’s investment bank has
received the following bids:
Solution:
Plan:
• First, we must compute the total number of shares
demanded at or above any given price. Then, we pick
the lowest price that will allow us to sell the full issue
(500,000 shares).
Execute:
• Convert the table of bids into a table of cumulative
demand:
Execute (cont'd):
• For example, the company has received bids for a total of
125,000 shares at $7.75 per share or higher (25,000 + 100,000 =
125,000).
• Fleming is offering a total of 500,000 shares. The winning
auction price would be $7.00 per share, because investors have
placed orders for a total of 500,000 shares at a price of $7.00 or
higher. All investors who placed bids of at least this price will be
able to buy the stock for $7.00 per share, even if their initial bid
was higher.
Execute (cont'd):
• In this example, the cumulative demand at the winning
price exactly equals the supply. If total demand at this
price were greater than supply, all auction participants
who bid prices higher than the winning price would
receive their full bid (at the winning price). Shares
would be awarded on a pro rata basis to bidders who
bid exactly the winning price.
Evaluate:
• While the auction IPO does not provide the
certainty of the firm commitment, it has the
advantage of using the market to determine the
offer price. It also reduces the underwriter’s
role, and consequently, fees.
Problem:
• Fleming Educational Software, Inc., is selling 1,000,000 shares of stock in an
auction IPO. At the end of the bidding period, Fleming’s investment bank has
received the following bids:
Price ($) Number of Shares Bid
20.00 250,000
19.50 225,000
19.00 175,000
18.50 200,000
18.00 150,000
17.50 125,000
17.00 75,000
• What will the offer price of the shares be?
Solution:
Plan:
• First, we must compute the total number of shares
demanded at or above any given price. Then, we pick
the lowest price that will allow us to sell the full issue
(1,000,000 shares).
Execute:
• Convert the table of bids into a table of cumulative
demand: Price ($) Cumulative Demand
20.00 250,000
19.50 475,000
19.00 650,000
18.50 850,000
18.00 1,000,000
17.50 1,125,000
17.00 1,200,000
Execute (cont'd):
• For example, the company has received bids for a total of
725,000 shares at $19.50 per share or higher (250,000 + 225,000
= 475,000).
• Fleming is offering a total of 1,000,000 shares. The winning
auction price would be $18.00 per share, because investors have
placed orders for a total of 1,000,000 shares at a price of $18.00
or higher. All investors who placed bids of at least this price will
be able to buy the stock for $18.00 per share, even if their initial
bid was higher.
Execute (cont'd):
• In this example, the cumulative demand at the winning
price exactly equals the supply. If total demand at this
price were greater than supply, all auction participants
who bid prices higher than the winning price would
receive their full bid (at the winning price). Shares
would be awarded on a pro rata basis to bidders who
bid exactly the winning price.
Evaluate:
• While the auction IPO does not provide the
certainty of the firm commitment, it has the
advantage of using the market to determine the
offer price. It also reduces the underwriter’s
role, and consequently, fees.
Google’s IPO
• On April 29, 2004, Google, Inc., announced plans to go public.
Breaking with tradition, Google startled Wall Street by declaring
its intention to rely heavily on the auction IPO mechanism for
distributing its shares. Google had been profitable since 2001, so,
according to Google executives, access to capital was not the
only motive to go public. The company also wanted to provide
employees and private equity investors with liquidity.
• Underpriced IPOs
On average, between 1960 and 2003, the price in the
U.S. aftermarket was 18.3% higher at the end of the
first day of trading
Who wins and who loses because of underpricing?
Money Left on the Table
Sample Average
Study Period Underpricing
Dawson (1987) 1978-1983 166.70%
Ismail, Abidin and Nasarudin (1993) 1980-1989 114.60%
Lougran, Ritter and Rydqvist (1994) 1980-1991 80.30%
Yong (1996) 1990-1994 72.85%
Leong, Vos and Tourani-Rad (2000) 1992-1998 107.00%
Abdullah and Taufil (2004) 1992-1998 78.44%
Chong et.al (2005) 1991-2001 90.40%
Chong et.al (2007) 1991-2003 66.50%
Yatim (2012) 1999-2008 28.00%
Che Yahya and Abdul Rahim (2012) 2000-2010 27.17
Ramlee and Ali (2012) 1998-2008 22.85%
Total 135
Copyright © 2009 Pearson Prentice Hall. All rights reserved. 184 319 13-80
13.3 IPO Puzzles
13-82
13.3 IPO Puzzles
Poor Post-IPO Long-Run Stock Performance
Newly listed firms appear to perform relatively poorly over the following
three to five years after their IPOs
The empirical evidence on long-term returns of IPO stocks are still
inconclusive, with the majority of developed stock markets reporting
underperformance (Ritter, 1991; Loughran and Ritter, 1995 and Welch and
Ritter, 2003) whilst their developing counterparts show over-performance
(Kiymaz, 2002; Chen, Hung and Wu, 2002; and Chan, Wang and Wei, 2004).
In the Malaysian IPO market, the literature consistently documents a positive
market adjusted long-term performance.
Jelic et al. (2001) report that Malaysian IPOs have positive returns up to 3 years after listing.
Corhay, Teo and Tourani-Rad (2002) found that Malaysian IPOs outperformed the market
with a mean (CAR) of 41.7% (BAHR) of 39.6% over a three year period after listing.
Ahmad-Zaluki, Campbell and Goodacre (2007) report positive buy and hold returns of
17.86% for IPOs listed on Bursa Malaysia Main Board over the period of 1990 to 2000.
Chong (2008) reports a meager positive equal weighted market adjusted buy-and-hold-
return of 0.66% for 132 main board samples from 1991 to 2003.
Copyright © 2009 Pearson Prentice Hall. All rights reserved. 13-83
Long-Term Return and Liquidity
Analysis by Cohort Year (Msian)
1999 18 0.680 -0.488 0.105 -1.556 -0.960 0.351 21.15 12.19 9.34 105.13 61.62 51.84
2000 36 -1.767 -0.625 -0.607 -1.097 -0.315 -0.510 15.69 13.76 10.36 156.35 105.43 81.14
2001 20 -1.051 -1.023 -0.749 0.091 -1.136 -2.013 20.62 14.40 12.01 153.32 111.00 94.28
2002 39 -0.189 -0.441 -1.044 0.553 0.381 0.484 13.34 16.43 12.56 126.12 118.40 96.58
2003 36 -1.189 -2.212 -2.080 0.103 -0.576 -0.821 17.89 11.32 10.34 137.24 101.50 75.43
2004 40 -2.068 -2.268 -2.138 -1.012 -1.582 -1.437 9.87 6.51 6.56 139.69 88.84 73.40
2005 27 -0.576 -0.676 -1.087 -1.012 -1.582 -1.437 9.82 7.56 6.94 94.17 65.14 56.36
2006 13 1.502 0.339 -0.247 2.503 0.027 0.534 17.33 11.40 9.05 128.18 98.03 64.31
2007 19 -1.661 -1.296 -1.094 -1.672 -1.321 -1.023 7.63 4.80 4.00 109.21 42.26 34.34
2008 15 0.563 0.053 -0.392 -5.085 -0.948 -0.455 4.96 4.48 4.44 38.85 34.44 36.37
Total/ 283 -0.821 -0.966 -1.094 -1.431 -0.560 -0.490 11.54 9.06 7.85 120.64 86.78 70.49
Average
• SEO Process
When a firm issues stock using an SEO, it follows
many of the same steps as for an IPO. The main
difference is that a market price for the stock already
exists, so the price-setting process is not necessary.
Tombstones
Problem:
• You are the CFO of a company that has a market
capitalization of $1 billion. The firm has 100
million shares outstanding, so the shares are
trading at $10 per share. You need to raise $200
million and have announced a rights issue. Each
existing shareholder is sent one right for every
share he or she owns.
Problem (cont'd):
• You have not decided how many rights you will
require to purchase a share of new stock. You
will require either four rights to purchase one
share at a price of $8 per share, or five rights to
purchase two new shares at a price of $5 per
share. Which approach will raise more money?
Solution:
Plan:
• In order to know how much money will be
raised, we need to compute how many total
shares would be purchased if everyone exercises
their rights. Then we can multiply it by the price
per share to calculate the total amount raised.
Execute:
• There are 100 million shares, each with one right attached. In
the first case, 4 rights will be needed to purchase a new share, so
100 million / 4 = 25 million new shares will be purchased. At a
price of $8 per share, that would raise $8 x 25 million = $200
million.
• In the second case, for every 5 rights, 2 new shares can be
purchased, so there will be 2 x (100 million / 5) = 40 million
new shares. At a price of $5 per share, that would also raise $200
million. If all shareholders exercise their rights, both approaches
will raise the same amount of money.
Evaluate:
• In both cases, the value of the firm after the issue is
$1.2 billion. In the first case, there are 125 million
shares outstanding after the issue, so the price per share
after the issue is $1.2 billion / 125 million = $9.60. This
price exceeds the issue price of $8, so the shareholders
will exercise their rights. Because exercising will yield
a profit of ($9.60 – $8.00)/4 = $0.40 per right, the total
value per share to each shareholder is $9.60 + 0.40 =
$10.00.
Evaluate (cont'd):
• In the second case, the number of shares outstanding
will grow to 140 million, resulting in a post-issue stock
price of $1.2 billion / 140 million shares = $8.57 per
share (also higher than the issue price). Again, the
shareholders will exercise their rights, and receive a
total value per share of $8.57 + 2($8.57 - $5.00)/5 =
$10.00. Thus, in both cases the same amount of money
is raised and shareholders are equally well off.
Problem:
• You are the CFO of a company that has a market
capitalization of $5 billion. The firm has 250
million shares outstanding, so the shares are
trading at $20 per share. You need to raise $500
million and have announced a rights issue. Each
existing shareholder is sent one right for every
share he or she owns.
Problem (cont'd):
• You have not decided how many rights you will
require to purchase a share of new stock. You
will require either five rights to purchase one
share at a price of $10 per share, or ten rights to
purchase three new shares at a price of $6.67 per
share. Which approach will raise more money?
Solution:
Plan:
• In order to know how much money will be
raised, we need to compute how many total
shares would be purchased if everyone exercises
their rights. Then we can multiply it by the price
per share to calculate the total amount raised.
Execute:
• There are 250 million shares, each with one right attached. In
the first case, 5 rights will be needed to purchase a new share, so
250 million / 5 = 50 million new shares will be purchased. At a
price of $10 per share, that would raise $10 x 50 million = $500
million.
• In the second case, for every 10 rights, 3 new shares can be
purchased, so there will be 3 x (250 million / 10) = 75 million
new shares. At a price of $6.67 per share, that would also raise
$500 million. If all shareholders exercise their rights, both
approaches will raise the same amount of money.
Evaluate:
• In both cases, the value of the firm after the issue is
$5.5 billion. In the first case, there are 300 million
shares outstanding after the issue, so the price per share
after the issue is $5.5 billion / 300 million = $18.33.
This price exceeds the issue price of $10, so the
shareholders will exercise their rights. Because
exercising will yield a profit of ($18.33 – $10.00)/5 =
$1.67 per right, the total value per share to each
shareholder is $18.33 + 1.67 = $20.00.
Evaluate (cont'd):
• In the second case, the number of shares outstanding
will grow to 325 million, resulting in a post-issue stock
price of $5.5 billion / 325 million shares = $16.92 per
share (also higher than the issue price). Again, the
shareholders will exercise their rights, and receive a
total value per share of $16.92 + 3($16.92 - $6.67)/10 =
$20.00. Thus, in both cases the same amount of money
is raised and shareholders are equally well off.
• SEO Costs
In addition to the price drop when the SEO is
announced, the firm must pay direct costs as well.
Underwriting fees amount to 5% of the proceeds of
the issue